April 19 (Bloomberg) -- As Texas warns of potential power
shortages and blackouts this summer, the state’s biggest
electricity producer is teetering toward bankruptcy. That may
turn out to be a boon to the $34 billion Texas power market.

A reorganization of Energy Future Holdings Corp., which
lost money because of low natural gas prices after the largest
leveraged buyout, would probably leave its power-generating unit
with less debt and more free cash to invest in improving output
capacity, according to former Texas regulator Brett Perlman.
Power demand in Texas is growing faster than supplies, which may
force the state to call for conservation on the hottest days
this year.

“We have the biggest generation owner in the state
sidelined and unable to seriously contribute to addressing our
capacity needs,” said Perlman, who served on the Public Utility
Commission of Texas when power markets were deregulated more
than 10 years ago and is now president of energy consultant
Vector Advisors. “A restructuring could potentially help
address that situation.”

The struggles of the Dallas-based company formerly called
TXU Corp. illustrate the risk investors face in betting on
deregulated electric markets, where wide price swings can
produce big profits or big losses. Other generators in
competitive markets have been hurt by falling prices, including
Dynegy Inc., which emerged from bankruptcy last year, and Edison
International’s generation unit, which filed for Chapter 11
reorganization in December.

Gas Plunge

A plunge in gas prices to a 10-year low last year doomed
Energy Future’s $48 billion buyout, which was a gamble that gas
rates would push up power prices and give its nuclear and coal-fired plants a competitive advantage.

Energy Future proposed a pre-packaged bankruptcy plan to
restructure $32 billion in debt held by its Texas Competitive
Electric Holdings subsidiary in exchange for equity in Energy
Future and $5 billion in cash or new debt, according to an April
15 regulatory filing. The deal was rejected by creditors.

KKR & Co. and TPG Capital LP, the private-equity sponsors
who led the 2007 buyout, said they want to retain a 15 percent
equity stake in the company as an opening salvo in restructuring
talks that may take many months to resolve.

Energy Future says it has done its share for the Texas
power market, spending $3.25 billion to build three new coal
units, planned before the buyout, the last of which came online
in 2010. Since 2008, the company has spent more than $5 billion
at Luminant, its generation unit, and TXU Energy, its retail
marketing arm, adding almost 1,900 jobs company wide, according
to a February investor presentation.

Adding Plants

Energy Future has added about 2,200 megawatts to the
state’s grid since 2007, more than any other generator and
bringing it within about 1,000 megawatts of the capacity cap set
by regulators in Texas for any single generator. To add more,
Energy Future would need to retire older units or transfer
ownership, said Allan Koenig, a company spokesman.

Falling prices have affected every generator’s ability to
invest in new projects, Koenig said.

In the past three years, Energy Future’s investment in
power plants and equipment hasn’t replaced the value of the
assets as they deteriorate, regulatory filings show. Last year,
capital spending at the company’s competitive unit were $630
million, less than half the $1.34 billion it recorded for
depreciation and amortization, according to a filing.

And while competitors announced plans to spend at least $3
billion since 2011 on new plants to meet rising energy demand,
Energy Future introduced no new projects.

Rebounding Investment?

Texas Competitive’s $1.83 billion of 10.25 percent notes
due November 2015 rose 0.5 cent to 10.5 cents on the dollar at
4:41 p.m. in New York, according to Trace, the bond-price
reporting system of the Financial Industry Regulatory Authority.

Restructuring may shift ownership of the power plants to
deeper-pocketed investors at a time when circumstances are
turning more in favor of expanding investment. The company
expects power prices, tied to fluctuations in gas costs, to
rebound over the coming years, improving cash flow.

And Texas regulators are poised to offer more financial
incentives to increase the amount of power available for demand
peaks during the state’s searing summer days.

Texas faces a rising risk of blackouts as it struggles to
keep up with increasing demand, the Electric Reliability Council
of Texas, which operates most of the state grid, said March 1.

Energy Future’s debt, a legacy of its buyout, may limit
funds needed for operations or to build power plants, the
company said in a February regulatory filing.

Paying Interest

In 2012, about 62 percent of Energy Future’s $5.6 billion
in revenue went to pay debt interest, according to data compiled
by Bloomberg. That compares to an industry average of 6.4
percent, according to the Edison Electric Institute, an industry
trade group.

“If you are using a lot of your cash flow to cover
interest expense, you are going to have much less available for
investing in new plants,” said Peter Thornton, an analyst for
KDP Investment Advisors Inc.

Energy Future expects earnings at its competitive power
unit will tumble by 33 percent through 2017 as gas hedging
contracts expire, according to an April 15 filing. Adjusted
earnings before interest, taxes, depreciation and amortization
at Texas Competitive will fall to $1.83 billion in 2017 from
$2.75 billion this year, totals that don’t include “expenses to
upgrade or expand” its power plants, the company said.

Depreciation Equation

Energy Future has allowed depreciation of its power plants
to outpace investment in the past three years in part to save
cash for debt payments, said Joseph DeSapri, a credit analyst at
Morningstar Inc.

Capital spending at rival independent power producers was
about twice as much as depreciation and amortization in 2012,
according to data compiled by Bloomberg.

The collapse in gas prices has led to losses in Energy
Future’s last eight consecutive quarters. The company’s
competitive unit, which owns nearly one-fifth of the power
supplies in Texas, faces a “material restructuring” within six
months to a year, Moody’s Investors Service said in March 26
note.

With profits sapped by low prices in Texas, other
generators including NRG Energy Inc. have been reluctant to
expand.

Deregulated Texas

In Texas’s deregulated system, generators are paid for
electricity at wholesale rates set by the market instead of
state-regulated prices that allow for a certain return of
profit. Some power companies are looking forward to a rebound,
encouraged by regulators’ decision to raise wholesale power
price caps last year and their consideration of additional
financial incentives to build.

Closely held Panda Power Funds LP and FGE Power LLC plan to
build nearly 3,000 megawatts of gas-fired generation, the
companies have said. Spending on those units could be as much as
$3 billion, based on a government cost estimates of about $1,000
a kilowatt for a new gas plant. Calpine Corp. is adding 520
megawatts of gas generation at an estimated cost of less than
$286 million.

In the past three years, competing generators have entered
agreements to add about 9,500 megawatts to Texas, according to
the state grid operator.

In a Luminant bankruptcy, some lenders would probably
exchange some of Energy Future’s debt for ownership of power
plants, said Andy DeVries, an analyst at CreditSights Inc.

Interested Rivals

Private-equity investors as well as power companies such as
NRG Energy Inc. and Calpine may show interest in buying some of
Energy Future’s power plants at discounted prices if they sell
some assets to pay secured creditors, DeSapri said.

Southern Co., the second-largest U.S. power producer, is
among the investors scouting Texas power plants. Southern’s
competitive unit, which invests in renewables and gas-fueled
plants, is looking at investing in Texas and the Midwest, Thomas
Fanning, Southern’s chairman and chief executive officer, said
during the company’s Jan. 30 earnings call. Tim Leljedal, a
spokesman for Atlanta-based Southern, declined to comment on
whether it would buy Energy Future’s plants.

Reviving Plants

NRG, the second-biggest power producer in Texas, isn’t
setting aside funds for potential acquisitions of Energy Future
assets and doesn’t see them becoming available for several
years, Chief Executive Officer David Crane said during a March 1
interview. Norma Dunn, a Calpine spokeswoman, declined to
comment.

Energy Future’s old and mostly idled gas plants, which
produce about 5,100 megawatts, may be repowered with new
turbines for about half the cost of a new gas generator, DeVries
said.

New investment will depend on the market outlook after a
restructuring, said Paul Patterson, an analyst for Glenrock
Associates LLC.

Still, a post-bankruptcy Energy Future lightened of debt
would be in a better position to invest, said Kenneth Anderson,
a commissioner with the Public Utility Commission of Texas.

“If they could retire and replace older plants with new
gas-fired generation, it could improve their competitive
situation.”